P3-26 Changes in cost Structure; Break-Even
Analysis; Operating Leverage; Margin of Safety ( LO 3 -4, LO 3 -6, LO 3 – 7, LO
3 -8)
P3-26 Frieden
Company’s contribution format income statement for the most recent month is
given below:
Sales (40,000 units) ……………………………………….. $ 800, 000
Variable expenses ………………………………………….. 560,
000
Contribution margin ……………………………………….. 240, 000
Fixed expenses ………………………………………………. 192, 000
Net operating income …………………………………….. $ 48, 000
The industry in which Frieden Company operates is
quite sensitive to cyclical movements in the economy. Thus profits vary
considerable from year to year according to general economic conditions. The
company has a large amount of unused capacity and is studying ways of improving
profits.
REQUIRED:
1. New equipment has come on the market that would
allow Frieden Company to automate a portion of its operations. Variable
expenses would be reduced by $6 per unit. However, fixed expenses would
increase to a total of $432,000 each month. Prepare two contribution format
income statements, one showing present operations and one showing how
operations would appear if the new equipment is purchased. Show an amount
column, a Per Unit column, and a Percent Column on each statement. Do not show
percentages for the fixed expenses.
2. Refer to the income statements in (1) above. For
both present operations and the proposed new operations, compute (a) the degree
of operating leverage. (b) the Break-Even Point in dollars, and (c) the margin
of safety in both dollars and percentage terms.
3. Refer again, to the data in (1) above. As a
manager, what factor would be paramount in your mind in deciding whether to
purchase the new equipment? (Assume that ample funds are available to make the
purchase).
4. Refer to the original data. Rather than purchase
new equipment, the marketing manager argues that the company’s marketing
strategy should be changed. Instead of paying sales commissions, which are
included in variable expenses, the marketing manager suggests that salespersons
be paid fixed salaries and that the company invest heavily in advertising. The
marketing manager claims that this new approach would increase unit sales by
50% without any change in selling price; the company’s new monthly fixed
expenses would be $240,000; and its net operating income would increase by 25%.
Compute the Break-Event-Point in dollar sales for
the company under the new marketing strategy.
Do you agree with the marketing manager’s proposal?
TUTORIAL PREVIEW
The income statements would be:
|
Present
|
|||
|
Amount
|
Per Unit
|
%
|
|
|
Sales
|
$800,000
|
$20
|
100%
|
|
Variable
expenses
|
560000
|
14
|
70%
|
file name: P3-26 Frieden Company.xls File type: .xls PRICE: $15
